Optimizing English and American security interests.

• Author: LoPucki, Lynn M.
• Position: III. Fixed Charges Compared with Security Interests C. Rights in Insolvency Proceedings through Conclusion, with footnotes, p. 1823-1863

3. Rights in Insolvency Proceedings

   Both English and American insolvency laws generally yield to and enforce the non-insolvency rights of security interest holders. (186) The creditor's "secured claim" is defined in the United States as the amount of the debt owed to the creditor that is secured by collateral. (187) Any excess over the value of the collateral is treated as an unsecured claim and will rank pro-rata with the claims of other unsecured creditors. (188) English law takes the same approach. A creditor has a "secured claim" for purposes of insolvency law "to the extent that [the creditor] holds any security for the debt ... over any property of the person by whom the debt is owed." (189) If the creditor "realizes [its] security [it] may prove for the balance of [its] debt, after deducting the amount realized" (190) for which it will rank pro-rata along with the unsecured creditors, (191)

   Both systems, however, also modify those rights in some respects. In this section, we compare the functions of English fixed charges and American security interests in connection with insolvency proceedings. Although general differences in the insolvency procedures of the two countries may indirectly affect secured creditor recoveries, we confine our discussion to differences that directly affect secured creditor recoveries.

   In the United States, three proceedings are commonly employed by business debtors: (1) Chapter 7 (liquidation), (2) Chapter 11 (reorganization), and (3) Chapter 13 (debt adjustment). We omit Chapter 13 debt adjustment from our comparison, because only individuals (natural persons) can file under Chapter 13.

   In England, four proceedings are commonly employed by business debtors: (1) Winding-up (liquidation), (2) Administration (reorganization), (3) Administrative Receivership (reorganization), and (4) Bankruptcy (distribution of bankrupt's estate and discharge), (192) We omit Administrative Receivership from our comparison, because recent legislation has sharply curtailed its use. (193) We also omit Bankruptcy from our comparison, because a bankruptcy order can only be made against individuals (natural persons). (194)

   Thus, following Segal, (195) we make essentially two comparisons. The first is of liquidation under American Chapter 7 with English Winding-up. The second is of reorganization under American Chapter 11 with English Administration.

   In theory, floating charges crystallize upon the commencement of an insolvency proceeding and so become fixed charges. But for purposes of insolvency proceedings, the metamorphosis seems to make little difference. The Insolvency Act defines a floating charge as a charge that was a floating charge at the time of its creation, (196) and continues to treat the floating charge differently in many respects. Accordingly, in this section we compare the insolvency treatment of charges that were created as fixed charges with American security interests. The comparison of charges that were created as floating charges with American security interests is the subject of Part IV.C. below. There are, nevertheless, many respects in which floating charges are treated the same as fixed charges. For economy of presentation, we mention some of them here.

   The insolvency treatment of English fixed charges is highly similar to the insolvency treatment of American security interests. We describe the similarities in subsection 1 before we turn to the differences in subsection 2.

   1. Similarities in Treatment

      Initiation. Secured creditors commonly initiate English insolvency proceedings. (197) They seldom do so directly in the United States. In the United States, unsecured creditors--which include secured creditors for the amounts by which their claims exceed the amounts of their collateral--have the legal right to initiate "involuntary" insolvency cases. (198) But American law is hostile toward direct creditor-initiation. Creditor petitions probably account for fewer than three percent of American business bankruptcies, (199)

      This difference in the ability of English and American secured creditors to directly initiate insolvency proceedings is, however, of little functional importance. Once the debtor is in default, an American secured creditor can force the debtor to file a "voluntary" petition by moving against the collateral, or merely threatening to move against the collateral. For example, an American creditor with a security interest in accounts can notify account debtors to pay the secured creditor directly, thus depriving the debtor of its cash flow. (200) An American creditor with a security interest in goods can file an action for replevin and probably have the sheriff poised to seize the debtor's property within ten to twenty days. (201) The debtor must then file a "voluntary" bankruptcy to avoid the seizure. Thus, although they use different devices, secured creditors commonly initiate both English and American insolvency proceedings.

      Automatic stay. In both England (202) and the United States, (203) the filing of an insolvency case stays the efforts of secured creditors to collect the debts owing to them, except through the insolvency case. In both systems, secured creditors are entitled to protection against loss resulting from the delay in realizing their collateral, (204) In both systems, secured creditors can petition the insolvency court for relief from the stay. (205)

      After-acquired property. After-acquired property, as the term is used here, refers to property that the debtor acquires after the commencement of the insolvency case and that fits within the security agreement description of collateral. In American insolvency proceedings, property acquired after the commencement of the case is not the secured creditor's collateral. Bankruptcy Code [section] 552(a) provides that "[P]roperty acquired by the estate or by the debtor after the commencement of the case is not subject to any lien resulting from any security agreement entered into by the debtor before the commencement of the case." (206) Such property is, however, subject to such a lien if it is also the proceeds, products, offspring, profits, or rents of collateral in existence at the time the insolvency proceeding was filed. (207) The purpose of the American rules is to distinguish situations in which the after-acquired property represents the value of the secured creditor's prepetition collateral, from situations in which the new value is contributed by the debtor's estate (308)

      English law makes essentially the same distinction in Winding-up proceedings. As Professor Goode states:

      So firmly is this principle [that security interests created prior to the insolvency proceeding are unaffected by the winding up] applied that where the instrument of charge provides for security in after-acquired property the secured creditor can assert rights even over moneys or other assets falling in after the commencement of the winding-up, provided that the consideration for these was already executed before that time, as opposed to being furnished by the liquidator himself, e.g., by performance of a contract entered into by the company. (209) Doctrinally, English law reaches this result through the construct that assets in the hands of a liquidator in Winding-up are subject to a statutory trust and so the company never becomes the beneficial owner of the after-acquired property. (210)

      Although authority with respect to fixed charges in Administration is sparse, Segal describes the scope of the English charge holder's right in after-acquired property as broader than the corresponding American right: "[W] here a post-petition product is made using assets or cash not previously subject to the lender's security interest, the new product will not be subject to the lender's lien. This is different from the position in an English administration...." (211) Segal does not say how, but does confirm that "the practical significance of the differences between the two systems is limited." (211)

      If we include authority regarding floating liens, the picture is clearer. The English statute addressing the sale of floating charge collateral employs the term "acquired property" essentially to mean "proceeds." The statute provides:

      [section] 70 (1) The administrator of a company may dispose of or take action relating to property which is subject to a floating charge as if it were not subject to the charge.

      (2) Where property is disposed of in reliance on sub-paragraph (1) the holder of the floating charge shall have the same priority in respect of acquired property as he had in respect of the property disposed of.

      (3) In sub-paragraph (2) "acquired property" means property of the company which directly or indirectly represents the property disposed of. (213)

      Under this provision, a floating charge holder retains its priority date only with respect to property "which directly or indirectly represents the property disposed of." (214) That is essentially the American concept of "proceeds." Segal's example confirms this interpretation:

      Accordingly, if the administrator, for example, sells plant machinery subject to the floating charge, the proceeds of the sale will fall within the floating charge and the holder of the charge will be entitled to the same priority as against third parties (e.g., holders of subsequent floating charges) in respect of the proceeds as he had over the disposed of plant machinery. (215) Thus, the distinction that after acquired property clauses continue to operate in English insolvency proceedings but cease to operate in American insolvency proceedings may make no difference. Whether the charge is fixed or floating, the English charge holder, like the American secured creditor, has effectively only the right to proceeds of its collateral during insolvency proceedings.

      Administrators. In a Chapter 7 liquidation case the United States Trustee, a government official, appoints a disinterested trustee to...